Dow Debate: Will Johnson & Johnson Crush Pfizer?

Johnson & Johnson's stock return in 2013 was well ahead of major market indices and also beat many of its sector peers, notably Pfizer . Indeed, while Johnson & Johnson posted a total return of 33.2% last year, besting both the S&P 500 (+26.4%) and the Dow Jones Industrial Average (+24.2%), Pfizer was only able to deliver a total return of 22.2%, lagging both indices.

However, this trend has been reversed in the first part of 2014, with Pfizer outperforming both of its benchmarks and Johnson & Johnson . Pfizer's shares are up around 3%, while Johnson & Johnson has risen about 1%.

Patent expirationsPfizer's share price gains have come in spite of the company's challenging fourth quarter, in which net profit was 59% lower than in the same period of 2012. As with many major pharmaceutical companies, it continues to struggle with generic competition, with a number of key, blockbuster drugs going off patent (or set to in the near future), which has a major effect on earnings.

For instance, generic versions of Celebrex are expected on the market in 2015 (after Pfizer received an extension to its patent), while generic forms of Viagra are due in the US by the end of 2017 (albeit under license, with Pfizer receiving a royalty). These two drugs alone contributed $4.8 billion (more than 9%) of Pfizer's revenue in 2013, so the market is right to be concerned about their loss.

Johnson & Johnson is also experiencing difficulties with patent expirations, with 2017 set to see the end of the patent on Velcade, while Remicade is due to lose its US patent in 2018 and its European patent in 2015. Indeed, the respective cancer and autoimmune disease drugs contributed $1.7 billion and $6.7 billion in revenue in 2013 (more than 11% of total sales).

Sales and pipeline developmentsJohnson & Johnson seems to have the advantage when it comes to future sales, with the company expected to deliver revenue growth over the next two years -- from $71.3 billion in 2013 to $77.5 billion in 2015. This compares favorably to Pfizer's total sales growth forecast for revenue to fall from roughly $51.5 billion in 2013 to $49.5 billion in 2015.

It isn't all doom and gloom for Pfizer , which has a number of potential catalysts in 2014. Indeed, its pipeline has experienced positive news in the first six weeks of 2014, with breast cancer drug palbociclib and pneumonia vaccine Prevnar having the potential for further upbeat developments to push shares higher throughout the year. These two drugs alone could contribute an additional $4 billion in revenue in future years.

Drug development also remains a key part of Johnson & Johnson's future plans, with the company gaining a number of FDA approvals in recent months. These include simeprevir for hepatitis C and ibrutinib for mantle cell lymphoma, as well as type 2 diabetes drug canagliflozin, which was approved in Europe (having been approved in the US in March 2013).

In addition to drug development, Johnson & Johnson continues to restructure toward what it deems to be faster-growing offerings. As a result, it recently sold off its blood-testing division to Carlyle Group for $4 billion. This highlights the diversity that Johnson & Johnson continues to offer investors, with diagnostic equipment and pharmaceuticals each making up about 40% of total sales, and consumer goods accounting for the final 20% of sales.

Payouts to shareholdersThe S&P 500's roughly 2% yield isn't too tough to beat, and the two drugmakers do just that -- Pfizer offers a yield of 2.7% and Johnson & Johnson delivers 2.5% (all TTM). Another dividend payer to consider isMerck, which yields 3.1%, although it sports a high payout ratio which, coupled with potential revenue losses in the future, may make it difficult for Merck to grow the dividend as much as Johnson & Johnson and Pfizer . Merck , of course, also suffers from a loss of patents and subsequent generic competition; like Pfizer, analysts expect to see sales fall, in this case from $44 billion in 2013 to slightly less than $43 billion in 2015.

Looking aheadThere is little to differentiate Pfizer and Johnson & Johnson in terms of their payouts to shareholders, with their yields being nearly identical. However, Johnson & Johnson is expected to grow its top line over the next two years, while Pfizer isn't. In addition, Johnson & Johnson is arguably a more stable business, since it is less reliant upon pipeline developments due to its diversification. As such, while it may not "crush" Pfizer , Johnson & Johnson certainly looks well-placed to have a strong 2014 and to outperform its rival. Unless, of course, Pfizer experiences positive surprises regarding its pipeline.

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